Investors cheered the government’s $2.2 trillion relief package last week. The S&P 500 climbed 17.8% from Monday through Thursday, although it did give back 3.4% on Friday when the deal actually passed the House. Investors recognized that, while the package will help brunt the blow, containing the virus will take longer than the few weeks for which some were hoping. Yesterday’s briefing by the Task Force extended the guidelines restricting economic activity to April 30th, rather than Easter Sunday, April 12th, as had been floated by the President last week. Much uncertainty remains about the depth and duration of the recession that we have already entered. When we look to past events to try to envision both the full scope of the disruption and the market’s eventual recovery, we find few similarities to either past market corrections or economic recessions. But in those differences, we can find insights and clues on how best to approach investing strategy from here.
Early on, investors looked to prior epidemics to try to get a measure of the challenges global economies would face. The market gyrations surrounding SARS, MERS or Ebola ended quickly, so while global markets sold off sharply in response to each, they also recovered rapidly. At the time, stocks declined because investors initially feared that each of those epidemics would materially slow economic activity. But in the end, those outbreaks were contained quickly and did not require the massive economic shutdowns countries around the world are using now to stem this pandemic.
At the other end of the spectrum, if we look at the most severe recessions and bear markets since 1950, the damage was more extensive and markets were slow to recover. The S&P 500 dropped 57% during the financial crisis and didn’t fully recover until 48 months later. The most lengthy recession prior to that one occurred in the 1970s when OPEC quadrupled oil prices.
During the 2008-09 Great Recession, our banking system was upended by a widespread failure in financial instruments and required a complex reformulation of institutional regulations and capital structures. Fixing the financial sector itself took years, and the ripple effects spread widely across the economy. The fiscal and monetary response was far more limited than it is now. During the oil crisis of the 1970s, consumer spending was sharply reduced by both high gas prices and higher electricity bills. Job losses exacerbated the decline in spending power. In addition, interest rates were among the highest in U.S. history, making borrowing costly.
Removing those two severe recession bear markets, we see that the average full stock market recovery from bear markets since 1950 was 23 months. In contrast to those two, the current recession does not emanate from any breakdown within the economy. This recession, unlike others, has been called a “recession by decree” or a “medically-induced coma” because controlling the virus demanded the shutdown. We haven’t suffered an implosion of the financial sector, as we did in 2008, nor are we suffering from a quadrupling of oil prices, as we did in the 1970s. Once we are allowed back out of our homes, businesses can resume operations, and will, indeed, have to catch up for lost time by manufacturing more rapidly than before. Some sectors, notably travel and leisure, will likely be slower to recover. Consumer spending will take some time to return and fiscal replacement of lost income for those idled or out of work is critical to preserve consumer spending power for the future. And while we don’t yet know for how long vast portions of the U.S. economy will need to remain offline, we do know that the impact is being mitigated by a far stronger fiscal and monetary response than we have seen in any prior recession. And more is likely to be forthcoming.
When we examine the market’s response to date, we find substantial deviations of company valuations from underlying fundamentals—even taking into account worst-case scenarios regarding the economic disruption of the coronavirus. We are adjusting our stock selections to take advantage of the most pronounced of these dislocations, with a recognition that we cannot know exactly when that recovery will arrive. The stock market may be quicker to recover than that 23-month average because we can switch back on economic activity once stay-at-home orders are lifted. A V-shaped recovery may ensue, but this is likely tempered by the extent of unemployment that arises in the meantime. As the months pass and we eventually contain the virus’s spread, businesses will reopen and profits will return. While some companies will suffer lower demand for longer (say, the cruise industry), others will return to normal relatively quickly (e.g., McDonalds). And investors will once again start to base the amount they are willing to pay for stocks on earnings potential in a more normal world.
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